In past offseasons, teams like the Yankees, Angels, and Dodgers have dominated the headlines by signing the top free agents on the market. After all, these teams operate in two of the biggest markets in the country, and they are capable of supporting large payrolls.
This offseason, though, these teams have been relatively quiet, especially on the free agent market. The Yankees have not been serious players for any of the top free agents this offseason, as they have instead opted to improve via trade by acquiring Aroldis Chapman. The Dodgers decided not to beat the Diamondbacks' offer for Zack Greinke, and their biggest move to date has been signing Scott Kazmir to a relatively modest deal. Likewise, the Angels have opted not to add significant contracts to their payroll, despite having a major need for a corner outfielder.
These teams still have time to make a splash in free agency, but it has nonetheless been curious to see them remain so quiet throughout the offseason. The Dodgers and Yankees have been the top two teams in payroll for the last three years, and the Angels are not far behind, as they have consistently carried a top five payroll over the last few years. We are used to seeing these teams spend money, and the fact that they are not spending like they normally do suggests that the luxury tax could be having an impact.
In Major League Baseball, the luxury tax is the closest thing there is to a salary cap. When teams spend over a certain threshold, they are taxed on each dollar spent over that threshold. The tax rate depends on how many years in a row a team has exceeded the luxury tax threshold. In the current CBA, first time violators are charged a 22.5 percent tax, second time violators a 30 percent tax, third time violators a 40 percent tax, and fourth time violators a 50 percent tax. (For more detailed information on the MLB luxury tax, I would highly recommend this piece by Nathaniel Grow over at FanGraphs.)
This framework incentivizes high payroll teams to get under the luxury tax threshold at least once every few years so that they do not get charged at higher rates for exceeding the threshold multiple years in a row. This is particularly relevant for the Dodgers and the Yankees, who have exceeded the luxury tax for multiple years now. The Yankees have exceeded the luxury tax threshold every year since 2003, the first year the tax was implemented in its current form. As a result, they are taxed at the highest rate of 50 percent. The Dodgers have exceeded the threshold by a significant amount each of the last three years, and they will likely do so again in 2016, since their payroll obligations are already over the $189 million threshold. (Cot's has them at just over $200 million after the Scott Kazmir signing.) As a result, they will also be taxed at the 50 percent rate next season.
While the Yankees and Dodgers are already over the luxury tax threshold for 2016, they could end up under the luxury tax threshold as soon as 2017, which would save them a significant amount of money by knocking them back down to the first time violator rate the next time they exceeded the tax threshold. The Yankees are set to lose three eight figure salaries after the 2016 season, as Mark Teixeira, Carlos Beltran, and CC Sabathia will become free agents. The Dodgers could also lower their payroll in the coming years, especially if they are able to receive significant contributions from players in their top-ranked farm system.
The Angels are in a slightly different situation, as they have not exceeded the luxury tax threshold in recent years. However, they are currently within striking distance of the luxury tax, as they already have $142 million in commitments for 2016 (according to Cot's), not including arbitration salaries and players who will make the league minimum. They have publicly stated that exceeding the luxury tax threshold probably does not make sense for them economically. While they are probably able to pay the first time violator rate of 22.5 percent, they may want to avoid the luxury tax entirely due to the escalating penalties. They could potentially find themselves in a slippery slope situation, where exceeding the luxury tax one year could make it easier to justify doing so again in future years.
Of course, we do not even know what the luxury tax will look like in the next CBA, which is set to begin after the 2016 season. Even if the current luxury tax format stays in place, we will likely see the luxury tax threshold continue to increase, perhaps above $200 million in the near future. Based on what we've seen this offseason, the Yankees, Dodgers, and Angels seems to believe that the luxury tax will remain in place for the next CBA.
In any case, the luxury tax appears to be serving its purpose of increasing competitive balance by reducing the amount large market teams spend on player salaries.